dependent and independent personal services july 2013

Dependent and Independent Personal Services

July 2013

► Overview

► Dependent Personal Services

► Taxability under Income tax Act, 1961

► Taxability under applicable Tax Treaty

► Relevant Issues

► Case Study

► Independent Personal Services

► Taxability under applicable Tax Treaty

► Relevant Issues

Contents

Overview

Overview

► Taxability of income arising from exercise of personal services under Tax treaties is governed by:

► Article on Dependent Personal Services: Personal services while in employment

► Article on Independent Personal Services: Personal services in independent capacity

Dependent Personal Services

► Salary earned for services rendered in India is taxable irrespective of residential status of the Individual and place of receipt of such salary

► Safe harbor for a non resident: Exemption under section 10(6)(vi) of Income-Tax Act, 1961 (the Act) is applicable where employee of Foreign Enterprise renders services in India provided :► Foreign Enterprise is not engaged in any trade/business in India► Stay in India does not exceed 90 days in the relevant tax year► Remuneration is not liable to be deducted from income of employer


Taxation of employment income under Income tax Act, 1961

► Governed by Article titled Dependent Personal Services / Income from Employment

► Applicability is restricted to employment income where recipient has employee- employer relationship with the payer

► Residence Rule (versus) Source Rule. E.g. Foreign national rendering services in India

► Availability of exemption from tax in “source country”► Concerned with cases of general applicability; not concerned with special

categories of employees such as consulate staff, UN employees


Taxability of employment income under the applicable Tax treaty


► Extract from Klaus Vogel on Double Taxation Conventions at page 899 :

“An employer is someone to whom an employee is committed to supply his capacity to work and under whose directions the latter engages in his activities and whose instructions he is bound to obey”

► Performance of duties subject to directions, instructions and superintendence of the employer

► Does not include:► Professionals, freelancers► Working partner► Director in his capacity as a Board member

Employer – Employee Relationship


► Employee presence is a pre-condition to exercise of employment► What is not relevant:

► Place where the result of work is exploited► Place of signing contract► Place of H.Q. of Employer► Residence of Employer► Nationality of Employee► Place of remittance of emoluments

► Visits in connection with employment

Place of Exercise of Employment


► India-US Tax treaty Article 16: Dependent Personal Services► Article 16(1)

“………………., salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived there from may be taxed in that other State.”

Right to Tax for Country of Residence


► India may consider remuneration derived by a US resident as not subject to tax in India if payout is not with respect to the employment exercised in India

► Any salary received in India is taxable under Income-Tax Act, 1961, however, it may be considered as not liable to tax under the applicable tax treaty:

► If recipient is resident of other state AND► The salary is in respect of an employment exercised outside India

Article 16(1) - Interpretation

Mechanics of Article 16(1) – India US Tax Treaty

Are you receiving salary income

Not covered under Dependent personal

services article

You are taxable in India

No

Yes, go to Dependent Personal Service Article

Yes

Yes

Are you the tax treaty resident of

India

Yes

No

Is salary related to services

rendered in India

Are you the tax treaty resident of

the US

No, you are rendering services in the US

You are taxable in India but you may claim credit of US

taxes


rendered in India

Yes


You are not taxable in India

Pay tax as per domestic tax laws

No

Taxability of an outbound employee

No


►Article 16(2) : India- USA Tax treaty

“Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if :

a) the recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in the relevant taxable year,

b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State; and

c) the remuneration is not borne by a permanent establishment or a fixed base or a trade or business which the employer has in the other State.”

Right to Tax for Source Country


► India can tax remuneration derived by a US resident in respect of an employment exercised in India if:► US resident is present in India during the relevant tax year for more than

183 days (Physical Presence Test)

(OR)► Remuneration to the US resident is paid by, or on behalf of employer who

is resident in India (Resident Employer Test)

(OR)► Remuneration to the US resident is borne by PE or Fixed base or

business or trade which the employer has in India (PE Connect Test)►Taxation in country of residence (US) is not affected

Article 16(2) - Interpretation


► India may exempt remuneration from tax derived by a US resident in respect of an employment exercised in India if:► US resident is present in India during the relevant tax year for 182 days or

less

(AND)► Remuneration to the US resident is paid by, or on behalf of employer who

is not resident in India

(AND)► Remuneration to the US resident is not borne by PE or Fixed base or

business or trade which the employer has in India

Article 16(2) – Another way of Interpretation


► Physical presence irrespective of time spent on activities► Include : Day of arrival; day of departure; holidays; vacations; voluntary or

involuntary interruptions, short breaks, sickness, etc.► Exclude : Days outside India even while on duty; training outside India in

connection with Indian duty; off period leave etc.► A part of the day is also a day► Mark : Concept of Fiscal year / Taxable year qua source country

Article 16(2) – Physical Presence Test


► India – US Tax treaty

“for a period or periods not exceeding in the aggregate 183 days in the relevant taxable year”

► India – UK Tax treaty

“period or periods not exceeding in the aggregate 183 days during the relevant fiscal year”

► India – Malaysia Tax treaty

“for a period or periods not exceeding in the aggregate 183 days in any twelve month period commencing or ending in the fiscal year concerned”

Article 16(2) – Physical Presence Test


► Who is the real / economic employer?► Employment contract► Control, superintendence, instruction, directions, manner of work

provisioning of tools and material for work, etc.► Code of conduct, dress code, service rules, who controls place of work,

reporting► Who enjoys confidentiality and fruits of labour► Responsible for conduct / risks of result of work► Bearing economic burden of salary cost

Article 16(2) – Resident Employer Test


► Remuneration ‘borne’ by PE► Logic : To compensate India for Tax Revenue lost through deduction► Employee functionally and economically connected with PE► Not relevant:

► Defrayal by HO and no charge back to PE► Not debited to PE Book► Deduction forgone by PE by choice► Capitalisation of amount in PE books

► Impact of presumptive taxation► Variants of “borne by”: deductible in computation of PE income, reasonably

connected etc.

Article 16(2) – PE Connect Test


► India- US Tax treaty

“the remuneration is not borne by a permanent establishment or a fixed base or a trade or business which the employer has in the other State”

► India – UK Tax treaty

“the remuneration is not deductible in computing the profits of an enterprise chargeable to tax in that other State”

► India- Malaysia Tax treaty

“the remuneration is not borne by a resident or permanent establishment or fixed base which the employer has in the other State or by a person carrying on independent personal services in the other Contracting State”

Article 16(2) – PE Connect Test

Mechanics of Article 16(2) – India US Tax TreatyAre you receiving salary

income

Not covered under Dependent personal

services article


No

Yes

No

Yes

Are you a treaty resident of India

No


rendered in India

Are you a treaty resident of the

US

No, you are rendering services in the US

You are taxable in India but you may claim credit of US

taxes


rendered in India

No


Pay tax as per domestic tax laws

No

Taxability of an inbound employee

Yes

Are you present in India for more than 182 days

Employer is a resident of India

Yes

Salary cost is borne by PE in

India

No


Yes

Yes

No

Yes


Dependent Personal Services – Some Relevant Issues


► The following changes are inserted in Section 90 with effect from April 1, 2013:

“An assessee, not being a resident, to whom an agreement referred to in sub-section (1) applies, shall not be entitled to claim any relief under such agreement unless a certificate of him being a resident in a country outside India or specified territory outside India, as the case may be, is obtained by him from the Government of that country or specified territory.”

► Applicable for financial year 2012-13 onwards

Tax Residency Certificate


US Company

Mr. X of Norway

Employment Contract

India

Exploring Business Opportunity for US

Company

Deputation for 4 months

Relevant Tax treaty: India – Norway

Short stay exemption will be calculated based on India-Norway Tax treaty

Triangular Situation


► Mr. X, UK national on assignment to India during 1 April 2013 to 30 September 2013, leaves India in October 2013

► Mr X has permanent home in the UK► Residential status: Domestic tax provisions

► Tie-breaker clause in the following order of preference to apply:► Permanent Home► Centre of Vital Interests (Personal and Economic Interest)► Habitual Abode► Nationality► Competent authorities

Period India UK

1 April 2013 to September 2013

Resident Non resident

1 October 2013 to March 2014 Resident Resident

Split Residency / Dual Residency

Dependent Personal Services – Case Studies


Scenario Fact Pattern

1 Tom (US resident) is in India for 190 days just exploring possibility of business for his US employer. US employer has no PE in India

2 Jerry (US resident) takes up employment with an Indian Company. He comes and works for 30 days. He leaves employment for personal reasons and believes he has no tax liability in India due to short stay

3 Harry (US resident) is employed by US Co. US Co renders services to various entities in India and has service PE in India. Harry, a specialist, comes for 3 days to India to address client emergency and criticality.

Case Studies

Facts► Mr. A is deputed to work with F Co.► F Co is a Dutch company paying taxes in India u/s 115A► The salary paid to Mr. A is not actually deducted while calculating taxable

profits of F Co.

Issue► Whether salary paid to Mr. A satisfies Article 15(2)(c) of the Tax treaty as

not being deductible expense for calculating profits of F Co.?


Case Studies

Facts► Mr. A is an employee of ABC US Co► Mr. A has rendered services in India in the branch office of ABC US Co for

76 days ► The salary paid to Mr. A by the branch office is reimbursed by ABC US Co

to the Indian branch.

Issue► Whether salary paid to Mr A satisfies Article 16(2)(c) of the Tax treaty as

not being deductible expense for calculating profits of PE?


Case Studies

Independent Personal Services


► Income from professional services/other activities of independent character► Professional services excludes:

► Professional services performed in employment► Industrial and commercial activities – covered under Article 5&7

► Professional services includes:► Independent scientific, literary, artistic, educational or teaching activities► Independent activities of physicians, lawyers, engineers, architects,

dentists and accountants► Other services of independent character

Overview


►Article 15 - India –US Tax treaty

“Income derived by a person who is an individual or firm of individuals (other than a company) who is a resident of a Contracting State from the performance in the other Contracting State of professional services or other independent activities of a similar character shall be taxable only in the first-mentioned State except in the following circumstances when such income may also be taxed in the other Contracting State:

(a) if such person has a fixed base regularly available to him in the other Contracting State for the purpose of performing his activities; in that case, only so much of the income as is attributable to that fixed base may be taxed in that other State; or

(b) if the person’s stay in the other Contracting State is for a period or periods amounting to or exceeding in the aggregate 90 days in the relevant taxable year.

The term “professional services” includes independent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, surgeons, lawyers, engineers, architects, dentists and accountants.”

Illustrative Treaty Example


► India can tax income derived by a US resident in respect of professional services rendered in India if :► US resident has a fixed base regularly available to him in India (Fixed

Base Test)

(OR)► US resident’s period of stay in India is more than 90 days in the relevant

tax year

Interpretation


► Inclusive definition

► Services of personal nature

► Independent character

► Employment income is excluded

► Professional knowledge of some department of science or learning is used

► An activity of independent character – though not qualified professional may also fall under the definition

Definition of Services


► What can be covered under - other services of independent character

► Distinguishable from business profit

► Should be service

► Should be similar to professional services

► Capital is of secondary importance

► Indian Tax treaties- by and large use the term “other services of independent character”

Definition of Services


► Treaty specific coverage of Individual and /or firms of Individuals

► India –US treaty: an Individual or a firm of individuals

► India – UK treaty: an Individual whether in his own capacity or as a

member of a partnership

► India – Singapore treaty: an Individual

► India – Netherlands / India –Japan: All residents including a company

which provides professional services

Entities Covered


► International commentaries suggest that a number of conditions must be

satisfied in order to constitute a Fixed Base of business

► There must be a place of business

► The place of business must be located at a certain area

► The individual must have a certain right of use to the place of business

► The use of place of business must last for a certain period of time

► The activities performed through the place of business must be a

business activity and such activities should constitute the core activities

Fixed Base Test


Fixed base Not a fixed base

Office of an architect / lawyer Auditor provided with a room at a client place for audit

Physician provided with a consulting room twice a week in a hospital

Desk made available to the manager situated in another enterprise without presence of necessary infrastructure

Definite space in an office of an associate

Temporary camping by a researcher at a base camp in Himalayas

A lawyer exercising profession from second home in another state

Illustration – Fixed Base


► Can non-Individuals render professional services?► Yes, if the applicable Tax treaty covers non-individuals. Tax treaties with

US, UK and Australia covers firms► MESB vs DIT (90 ITD793) – Article 14 can apply to non individuals

► Furnishing of services is also covered by Article 5 (Service PE)► Service PE Article 5 applies to service other than Independent Personal

Services► Article 5 covers furnishing of services by an enterprise through its

employees or other personnel engaged by the enterprise

Relevant Issues


► Is it possible that characterization of income would encompass Independent Personal Services as well as Fee for Technical Services?

► Specific will override general► MESB vs DIT (90 ITD793)- Elaborate explanation of professional services► DCIT vs Chadbourne & Park LLP – 2005 2 SOT 434 (Mum)

Relevant Issues

Thank You

dependent and independent personal services july 2013

Documents

exercise of personal

employment slide

employment article

income tax act

income tax act

applicable tax treaty

employment place of

employment applicability